The Inflation Myth

This week we feel it is necessary to revisit a subject that has been the focus
of a great many headlines recently: inflation.

Lately the investing public has taken note of rising prices of goods and services,
which have sparked inflation worries. These worries have been further spurred
by the government's "printing" of money through quantitative easing ("QE")
and more recently "QE2." Of course, pop-economists, fear mongers, and gold
bugs certainly haven't helped.

Much of the concern surrounding prospects of inflation is based on popular
misconception of how inflation is defined.

Inflation, as defined by the American College Dictionary, is growth in money
supply that exceeds growth in the economy, as measured by Gross Domestic Product.
It is purely a monetary event. Contrary to popular opinion, inflation is NOT
defined as rising prices. Admittedly, it is sometimes characterized by
price increases.

Based on the correct definition, current inflation worries are easily dismissed
as unfounded, as money supply growth in this country has actually been negative for
the past 18 months. This
certainly doesn't mean that inflation won't become a real worry in the future.
It simply means that current circumstances do not warrant anxiety.

Unfortunately, the government is often misleading (imagine that: the government
misleading citizens) in its reporting of inflation. Up until about five years
ago, the popular metric for tracking inflation was M3, a broad measure of money
supply. However, since it's discontinuation (how convenient), the government
has instead reported inflation through the Consumer Price Index, or CPI.

The change in CPI, the government asserts, is a realistic picture of inflation
in this country, as CPI measures the changing cost of a set basket of goods.
In essence, CPI is the government's way of measuring changes in the US cost
of living.

So, while investors and even government officials like Ben
Bernanke note the rising prices reflected in CPI, in truth the
prospects of inflation in the near term (the next six months) are extremely
low. Money supply growth continues to stay in negative territory, and it
does not appear poised to resume positive growth, let alone a rate of increase
that would exceed recent growth in the economy.

It is certainly true that recently the prices of some goods and services have
risen, though the cause of such increases is a matter for debate. Based on
our research, it appears that such price increases are more likely due to simply
supply and demand, as opposed to inflation.

For example, the prices of many food stuffs have risen, mostly because recent
deep cold snaps in the southern United States caused crops to freeze. Naturally,
less supply has driven up costs. Likewise, the price of gasoline has obviously
risen, but this is undoubtedly because the turmoil in the Middle East has threatened
the flow of oil supplies, not because the US government is expanding the money
supply - a claim that we still judge to be false.

Contrary to now-popular opinion (we say now-popular because we were worried
about inflation more than a decade ago and were able to position ourselves
and our clients to benefit from it, which they did), inflation isn't behind
every increase in prices. It's important to remember that increasing prices
are a symptom of inflation, not vice versa. Inflation is a monetary event,
meaning that it occurs when money supply expands faster than the economy. We
expect many investors to learn this distinction over the next several years,
and it will no doubt be expensive.

Dock David Treece is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com)
and is licensed with FINRA through Treece Financial Services Corp. He provides
expert content to numerous media outlets. The above information is the express
opinion of Dock David Treece and should not be construed as investment advice
or used without outside verification.